Gavin Andresen, Principal of the BitCoin Virtual Currency Project, talks with EconTalk host Russ Roberts about BitCoin, an innovative attempt to create a decentralized electronic currency. Andresen explains the origins of BitCoin, how new currency gets created, how you can acquire BitCoins and the prospects for BitCoin's future. Can it compete with government-sanctioned money? How can users trust it? What threatens BitCoin and how might it thrive?

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0:36

Intro. [Recording date: March 15, 2011.] I get a lot of emails to encourage me to talk to people, and I think I've gotten more email to talk to BitCoin than any other person. Good thing for BitCoin. I think there's a lot of interest in the project. What is BitCoin, and what are its prospects for the future? The short, geeky answer is BitCoin is the world's first distributed electronic currency. If you are not a geek, some of those words probably don't make any sense to you. The non-geeky short answer is that it is a new kind of money that we are using on the Internet. Are you a geek, Gavin? I am a geek. I'm a programming geek. So, I may have to translate from time to time if you don't translate yourself. So, the non-geeky--this is Internet money, money available on the Internet to use. Where does it come from? Well, that's the interesting thing about it. About the money we typically think of in dollars and euros and credit cards that have one central organization that creates it and controls it, this is distributed. So, it's people running coin software on their computer; and the people running the software are actually the people who generate the bitcoins. So, how does it work? Well, from a user's perspective, you either sign up with an online service that holds your bitcoins for you, or you download this software and run it on your computer. And the software keeps track of the coins that you own. It gives you an interface to send bitcoins to other people; and also it has an option to try to generate bitcoins. So, you can actually try to create money out of thin air. We'll go into much more technical detail later on why that actually works. So, one of the challenges of any new currency is trust. Why don't you talk about the role that trust plays in currency generally, and what role it's playing with BitCoin? If you really think about it, money is all about trust. We trust our central bankers not to create money willy-nilly and have runaway inflation like they had in Zimbabwe. We trust that money is hard to counterfeit so that when we get a dollar bill from a merchant we are not getting something we take to the bank and the bank says: No, that's not a real dollar bill, sorry. Trust is huge. That's really the biggest barrier for BitCoin--to get everyday people to start trusting it, as opposed to people like me who are geeks. Getting the geeks to trust it I think will be fairly easy: it's a currency and open-source project. I've actually been leading the open-source project for the last month or two, and because it's open source, because anybody can look at what it's doing, people can and have been looking at it in detail, figuring out exactly if it's possible for somebody to steal your bitcoins, what exactly are the different ways somebody could create bitcoins that don't follow the rules. All these other things are hashed out completely in the open. So, in the last six months or so a lot of geeks have looked at it and become excited about it, because so far nobody has been able to poke holes in it. It seems to be a solid system that is trustworthy. Let's stop on that trust issue for another minute. Let's say you are a guest on my show--we don't pay, but let's say we paid you $100. If I give you $100 in cash, I could send you 5 $20-bills in the mail, which is a little bit nerve-wracking because they might get lost. Or I could send you a check for $100, and that check would allow you to draw on my resources, my currency that I've deposited in some form in a bank. The irony is there a certain high level of trust with current money, of all different layers and levels. For example, George Mason U., or Liberty Fund, which runs this podcast--if they want to send me money, I never see any cash. We have a pretend, a little fantasy, magic game we play, where they tell me they are sending me something. It's all electronic, all 1s and 0s that go into my bank account. I never see the cash. We think of money and payments as green pieces of paper, but increasingly they are not. There is a fiction involved that we are creating this thing called U.S. dollars. When I take the dollars from a pay source, or if you were to take my dollars, you accept them because you think you are going to be able to spend them. That's the most minimal level of trust. If no one took dollars, you'd be a fool to accept them as payment. You'd have something more reliable or something you thought you could spend. As you point out, if the government, which runs the dollar show, makes too many of them, then what you could buy with those dollars could change. You could still use the dollars, but what it would be able to purchase--it might say $100, or 5 $20s, but what you can get for 5 $20s might not be so stable. So, that's another issue of trust. Now how do those two issues--can I spend it and is it stable--am I going to get $20-worth of stuff for my $20-bill--how do those operate under BitCoin? The first issue, can I spend it, is tricky right now because the number of people who accept bitcoins for products or services is fairly small. Growing every day as the system becomes more popular, but getting enough people to trust it--chicken and egg problem of merchants don't want to accept bitcoins till lots of people are using them and people don't want to use bitcoins until lots of merchants and other people are accepting them. I don't think we have a lot of examples of a start-up currency where you are trying to bootstrap. Especially one that's extra-national, meaning outside national governance.

8:00

How many people right now do you estimate accept BitCoin? Right now probably about 100 or 200 different merchants that are accepting BitCoin for various products and services. That's growing. That's taken off in the last 6 months or so. I should back up and say that BitCoin has been going for about 2 years, but it's only been the last 6 months or so that the software has matured far enough that you can build web services on top of it and people have started to do that and accept bitcoins in their online shops. So, let's say I'm having trouble with my computer--which I always am, of course, and I ask a geeky guy or woman to fix my computer, and I say: Oh, and by the way, I want to pay you in BitCoin. And they are happy to accept that, because let's say they have a merchant who accepts BitCoin and that merchant has something they actually want to buy these days. So, how would I do that? Could I do that transaction now? Yes. The person you are paying will have a BitCoin address. Let's make it you, Gavin. I would send you one of my BitCoin receiving addresses. You would plug that in--you would copy and paste that--well, if your computer is broken you probably wouldn't use that computer; you'd use somebody else's to log on to one of these online wallet services. You would put my BitCoin receiving addresses, the amount you want to pay me, and press the Send button; and then the bitcoins would be transferred from your account to my account. And all of that is done magically behind the scenes. Almost instantaneously. At the speed of an email. You see it right away. There are actually some technical details in that it's not completely firmed up and confirmed for anywhere from 10 minutes to an hour. That's just because of the nature of the peer-to-peer network that's handling the transaction. So, you tell me you'll be happy to fix my computer for 50 bitcoins--is that the name of it, by the way? Yes, bitcoins. So, we agree on the price. But I don't have any. So, what do I do? Do I have to find another geek who has an urge to learn some economics and I'd give him a lecture and he'd pay me 50 bitcoins? That would work. There are bitcoin exchanges, which will exchange dollars for bitcoins, or bitcoins for dollars. So I can buy them. Yes, you can buy them using another currency. What's the exchange rate is about one bitcoin costs 90 cents; that's been varying a fair bit. I think a week or two ago it was actually up to a dollar. Those are two ways: I can earn them if somebody pays me in bitcoins, same way I get dollars; or I can swap them, the same way I get dollars if I'm French. Is there a third way? There is. You can generate them, or try to generate them. We haven't talked about how bitcoins are generated. The way the BitCoin system is designed, 50 bitcoins are created approximately every ten minutes. There is an algorithm that everybody is running on their computers who has the software, trying to generate bitcoins. Essentially you are in a race to try to be the first one to solve a cryptographic problem to generate new bitcoins, and if you happen to be lucky enough to win that race, then you announce to the network: I have created 50 new bitcoins. And all of the rest of the network checks to make sure you actually did solve the problem correctly. If you did, your new bitcoins will be accepted into the system and you'll have 50 brand new, shiny bitcoins to spend. So, the classic metaphor for increasing the money supply by the central bank is a helicopter drop, which isn't what they actually do. What they actually do is buy assets and put money into the economy that way. But this is the equivalent: you are adding bitcoins in a very specific, steady way into the system. The algorithm is actually very clever, and it's designed to be incredibly stable. Right now the rule is 50 bitcoins approximately every ten minutes. And the entire network of computers adjusts the difficulty of this problem that's being solved such that across the entire network, no matter how many people are trying to create bitcoins, only 50 are generated every 10 minutes. As more people join, more computers are working hard on this race, the finish line gets farther away, so on average it still takes 10 minutes for somebody across the network to solve the problem and generate the 50 bitcoins. You said there's 100-200 merchants who accept them--how many people have the software on their computers to hold bitcoins, to use them? It's a little bit hard to tell. Roughly 5,000-10,000 people last time I checked, a month ago. That's the number of people actively connected to the BitCoin network. I should say you don't have to actively be connected to the BitCoin network to use bitcoins. You can use one of these online wallet services and they'll connect to it for you. So, it's hard to tell how many people are using those online wallet services--I don't have numbers on that. Somewhere in that 5-10,000, maybe as many as 15,000 range.

14:34

Why do you want to increase the number? Tell us the origins of BitCoin and why the decision was made to have that steady increase; and is it perpetual? The origin is interesting. It was actually created by this mysterious person who calls himself Satoshi Nakamoto. I have never met him or spoken to him over the telephone; I have only communicated with him electronically. I'm pretty sure he is actually a student and that is not his real name. But he's a mysterious, very talented computer programmer who figured out how to make it work and then did all of the work of actually implementing BitCoin before he announced it onto a cryptography mailing list and then launched it as an open source project. Tell us what open source means. Open source means that the source code, the computer programming language code, is available for anybody to look at; in this case it's available for anybody to take and modify, do whatever you like with it. Completely free and open. What stops somebody from altering the rate of growth from 50 to 75 bitcoins in 10 minutes? If somebody tried to do that, then everybody else would check their bitcoins and see that the rate that they are creating them wouldn't match what everybody else agrees should be the rate, and everybody else would just reject their bitcoins. They wouldn't be accepted. Nothing stops you from taking the BitCoin software and creating your own version of the system that has different rules. That's very easy technically. The hard part is to get anybody else to actually use your new currency. Why would they want to use your currency if no merchant has an infrastructure built up around it. So, when you say it's open source, it is not open source to alter the current system of BitCoin. That's stuck in place. Yes. We do alter it; we do fix bugs; we do talk about changing kind of on the margins the way the system works, to prevent security breaches or other things. You ask why 50 bitcoins, why was it designed that way. Those kinds of core rules are pretty set in stone. It would require a majority of people running the software to agree: Yeah, we think 50 is not the right amount; let's generate 100 every time, every four minutes, or whatever. You'd have to convince the majority of people that that was a good idea and then give the software to download and run a new version of BitCoin. So, when you say you do alter it, worry about security breaches, check for bugs, improve it--who is "we"? BitCoin is actually a pretty loosely organized open source project, so anybody who is interested in working on it--and this is how I got involved; I actually found out about BitCoin last May, started looking into it, got convinced it would work; started writing code into patches for it. Six months later I'm kind of the de factor leader of the technical project. There is no official BitCoin organization. It is just an open source project with a website, BitCoin.org, and anybody interested can come in and work on it. The better your code, the more likely it is to get accepted by all the people running the BitCoin software and the more likely it is, those of us who have access to the official version of the software, to approve your changes and allow you in.

19:12

For those of us who aren't geeks, help us understand how that open source approval works. For example, let's suppose one of the users sees a way to make the system work faster, and they propose a change in the code; but they sneak in a little thing that funnels bitcoins to themselves. You're laughing--maybe a stupid question? Or maybe a great idea? Oh, no, it's not a stupid question. What stops that from happening. The process is: On the BitCoin.org website there are forums where we talk about potential changes; there's a source code repository where all the source code lives. Any time any change is made to the source code, everybody sees it. You can easily see what the changes were. In your case, if there was some funky code checked into the source tree that made bitcoins go someplace else, there are going to be at least 10-15 people looking at every change and wondering: What is this line of code about right here? So, there actually is quite a lot of scrutiny that goes into every change that goes into BitCoin. It's community consensus as to which changes are accepted and which aren't. When you say consensus, is it a literal vote? Sometimes there are literal votes. Right now we are talking about whether we should enable universal plug-and-play, which is a way of opening up ports in your firewall. There is actually a thread in the message forums with a vote on whether it should be opened up or not, with lots of discussion and argument both ways. Looks like we are not going to, because that's the consensus. What other ways are there for making decisions about what to add or not to the code? If there are kind of critical high-risk security things, on those kinds of things Satoshi and I might just unilaterally decide this is an important enough fix that we just need to do it. No discussion. So, we will be benevolent dictators. What's the check on your benevolence? Everybody can see the code that changed; people could simply refuse to download the new version of the software. If not everybody downloads and uses the new software then the change doesn't happen because what people are actually running defines the rules. For those out there listening thinking maybe this is just some weird, goofy thing--what if he says that it's checked and a group of 10 people get together--there's all sorts of things people worry about, those unfamiliar with open source projects, right? Correct. For the people who are used to it, they'd say: Well, that's silly; we don't have to worry about that. But for those of us on the outside, it's like: I'm going to put my salary in there? But of course, we do this all the time with our regular bank. We assume they are not going to run away with the money--there's laws, a whole set of implicit things, some explicit but a lot of them are explicit, that keep us comfortable. One of the things the government does to us with their currency is they can inflate it the amount and deflate the value. Here you are saying it can't really happen; it would be extremely unlikely. And your assurance, to a normal person, is not that assuring; it's somewhat assuring. We are not really familiar with this. We'd probably have to go for a while, have friends who use it. Is that what you think will happen. Yes. The other thing that will happen is what's happening now, which is we will get multiple compatible implementations. So you don't have to trust that Satoshi and I are not going to let anything evil into the version of BitCoin that you download. There will also be a version--actually just recently an employee at Google has created a compatible implementation of BitCoin that he's been working on and that Google has approved. And it's also being released as open source. I think you also see branded versions, to get some of that trust. Wacky little open source project, but maybe if it has the Google brand name on it, that might help a lot of people trust it. I think it would. Not sure it should. We know they don't do evil.

24:27

We got sidetracked. Why 50 every ten minutes? And, is that forever? That's a good question. Is that a decision we'll make? The rules as they are currently designed, as I imagine they will remain, are 50 every 10 minutes for the first 4 years; and then the amount generated is cut in half every 10 minutes every subsequent 4 years. So, you'll get 25 bitcoins every 10 minutes. And after another 4 years it will be 12.5 bitcoins every 10 minutes. It was designed that way because it's designed to mimic natural resources. Designed to mimic digging gold out of the ground--you find a lot in the beginning, but then you work harder and harder, and go farther and farther, less and less to find. Presumably the exchange rate between bitcoins and dollars would have some relationship to that pace versus dollar creation. It's not clear. I'm not an economist--so maybe I should talk to one. The value is supply and demand. The supply is fixed by this generation rate; so I suppose if the generation rate is cut in half and growth in demand remains constant, then you are going to get price increases. No, I think it would go the other way. I'll just speculate for a minute; thinking off the top of my head. I think what's happening is there is a growth rate of bitcoins right now and it's going to slow over time. I saw a video presentation you did on this which we'll put a link up to. So basically it's rising at a decreasing rate, and eventually it's going to level off at some amount. That means that way into the future--8, 12, 16 years from now--the amount will be relatively stable, which means that if the dollars are not--if the Fed is behaving such that the money supply is growing rapidly, and the prices of things measured in dollars is going up at a steady, fast, maybe increasing rate, that bitcoins would get increasingly valuable. How many dollars you'd have to give up to get a bitcoin would go up because there's going to be what's called an arbitrage condition. Basically, if you can buy stuff with bitcoins in a world where both bitcoins and dollars are both used easily, bitcoins and dollars have to buy roughly the same amount of stuff. That's purchasing power parity. If it weren't true, you'd swap one for the other and change the rate. What it suggests is because the rate of bitcoin creating is going to be slowing over time, that in theory the prices of goods denominated in bitcoins would start to fall. I think that's right. BitCoin is kind of designed to become more valuable, if you think of them in terms of dollars--they will buy more dollars over time.

28:46

Now let's talk about some of the problems with bitcoins. The first issue that comes to my mind is taxes. Let's say I'm a freelancer; I spend half my time consulting for a bunch of different firms; and my other client I spend the other half of my time on. Let's say it's Google. And I tell Google: I don't want to be paid in dollars any more. I want to be paid in bitcoins. I'll accept the rate you've been paying me in the past, translated into bitcoins at the current bitcoin/dollar exchange rate. I'm willing to do that because I know there are enough merchants who sell stuff I want for at least half of the purchases I make right now. Now, if I do that, what are the tax consequences of that? I think it would be no different from earning any other foreign currency. So, if you earned money in euros, or if you did a barter transaction--I'm not an accountant or tax attorney, but I imagine the tax consequences would be the same. I think that's right for Google, because Google is really eager to comply with the laws of the United States. They have a lot at stake. So, I can't barter with Google. I can't say to Google: I want to work halftime here and instead of just giving me access to the free drinks and snacks that you have, I'd like one of the bikes you have on campus--I'd like to take one home; in fact, I'd like the car, but don't tell anybody. Google's not going to do that. That's all going to be taxable. But if I'm a freelance consultant with some friends, people in the tech community, I could see BitCoin as an attractive way to avoid taxes. Sure--it's just like cash that way. Or barter, which is taxable in theory; but just easy to avoid taxes if you take cash or barter. I wonder if that's a legal problem--not a problem; actually a feature, not a bug. But eventually the government may want to say something about that. There has been a lot of speculation in the BitCoin community about what will government reaction be to BitCoin; will it try to do something about it and can it do something about it? Those are interesting problems to have. The taxes are the least interesting, actually. Let's talk about the bigger issue, which is: one of the reasons that dollars are so valuable is that they are the only way you can pay taxes in the United States. And as a result, you are stuck using the government's system up to some point, or you go to jail. You can hide. You can try to evade the system, but if want to play within the system, you have to use dollars. In some sense that gives the dollar its ultimate reliability, because I can use the dollar to pay my taxes and stay out of jail. If everybody started using BitCoin, and the government solved this particular tax problem--evasion of taxes--but no one used dollars for anything else except just to convert bitcoins to dollars and pay your taxes--interesting issue as to what the government's ability to monitor the bitcoin system is. What I'm really asking is: What are the prospects for BitCoin replacing the dollar, or any national currency, and breaking the monopoly power of the Federal Reserve? I don't see any kind of theoretical barrier to that happening, although there are all sorts of practical barriers, the biggest of which is just trust. It's hard to imagine that happening. I could imagine that happening in maybe a smaller country that has decided to peg their currency to the dollar--maybe they decide to peg to the bitcoin or decide to use bitcoins as their national currency. I could see that happening before dollars gets replaced. But the biggest problem in those cases is they don't keep their promises. So, they promise to peg it to the bitcoin but then they break their promise. The reason the promise has so much appeal--besides that it's cool--it's very cool. Wouldn't it be great if we could just run our lives this way? If I knew that over the next four years bitcoins were going to be created 50 at a time every ten minutes, and I came to trust that, and then knew down the road it would be 25 and then 12.5 until the stock was basically fixed, I'd rather play in that sand pile rather than the one where I have to trust Ben Bernanke. Ben Bernanke will tell me we can't have that world because we need monetary policy to do x, y, and z; and I would say, yeah, I'll take my chances. I think that is the argument for really getting excited about this project for the non-geek community. It is; that's part of what really interested me, besides all that geeky cryptography and all that other cool stuff in there: the notion of taking back control of our money. Not trusting central bankers or some small, elite group of people to control it. What Milton Friedman said: let a computer control it. Predictable solid base on which all kinds of things can be built. Is anybody studying it? I haven't seen any economists studying it. I would really like to see that. I think one of the interesting things about BitCoin is all of the transactions are public. They are all announced across this peer-to-peer network and all stored for all time, so there's a wealth of data on what the money flows are. You could actually compute the velocity of money and all these other kind of abstract economic concepts that are hard to measure in the real world are a lot easier to measure in the BitCoin world because everything is controlled by this computer in this network. I hope some of my colleagues will find this of interest. Obviously you need a staff--you need a research department, a bunch of studies done; but for now you're not doing that. Sounds like there's not a lot of infrastructure there. Are you it? Well, me and everybody else who is interested in the project and creating tools around it. There's a cool website called BitCoinMonitor.com where you can go and actually see transactions going across the BitCoin network as they happen. You don't know who is paying whom, but you can see patterns of transactions; you can see the blocks being created. There are people who try to monitor the BitCoin network for people who cheat. All of that infrastructure is in the process of getting created. In addition to all the infrastructure of people creating shopping cart interfaces for websites and people accepting bitcoin on their websites and people thinking about bitcoin stock markets and bitcoin futures markets. Another big part of the reason I'm really excited about bitcoin is there is such a low barrier to innovation. It's open source. Get it, compile it, write some code around it; start creating transactions. Very little barrier to entry. I'm confident that we are going to see lots of interesting things happening really quickly.

38:03

Is there infrastructure that has to exist or is it all just sitting on everybody's systems? Just sitting on everybody's systems. You don't have a server in your home town or Satoshi's home town where this is all being stored? No, it's completely distributed at the moment. That will begin to change as we scale up. I don't want to oversell BitCoin. As we scale up there will be bumps along the way. I'm confident of it. Why? For example, as the volume of transactions come up--right now, I can run BitCoin on my personal computer and communicate over my DSL line; and I get every single transaction that's happening everywhere in the world. As we scale up, that won't be possible any more. If there are millions of bitcoin transactions happening every second, that will be a great problem for BitCoin to have--means it is very popular, very trusted--but obviously I won't be able to run it on my own personal computer. It will take dedicated fleets of computers with high-speed network interfaces, and that kind of big iron to actually do all that transaction processing. I'm confident that will happen and that will evolve. But right now all the people trying to generate bitcoins on their own computers and who like the fact that they can be a self-contained unit, I think they may not be so happy if BitCoin gets really big and they can no longer do that. Have to start to trust someone running these bigger data computers. One of the interesting parts about it, as an innovative project, is that there is the residual claimant, which is a fancy phrase in economics talk for the person who gets to make the money, gets to keep the profit. The residual claimant in a startup business is usually the owner, owners; and we know that opportunity to keep the profit and the risk of losing it keeps the owner alert to keep the product high quality. It can induce fraud and bad things too. But competition, alongside residual claimants' own interests are usually what forces businesses to serve their customers. But, in an open source project, Satoshi has pride in the project, but he doesn't make any money, right? He gets some glory. He might end up making some money, because of the fact that he was the first person who started generating bitcoins. It's as if he's the very first gold miner. He's got a good stash to start with. It's assumed that he has a fair number of those bitcoins that were generated in the first year after he quietly announced it and started it running. That's good. Right--he worked incredibly hard and had a brilliant idea for how to solve the last piece of the puzzle that allowed the whole thing to work. He has an incentive to keep its value high and not degrade it. He does. What is your stake? If you can talk about it. There is no stock; there are no bonuses. I try to spend half of my time working on the actual open source project itself, and the other half of my time creating a BitCoin-related startup. I'm hoping that my BitCoin-related startup will be successful. Working on the open source project because there's no chance that my BitCoin-related project will be successful if BitCoin fails. Do you receive a salary? No. I've done software startups in the past and my wife's a professor at the university, so I can afford to take a couple of years and try really risky things. So, in one dimension it's a labor of love--because it's cool and fun--and the other dimension is that it could lead to something profitable for you through these other ventures. I'm hoping so. How many are there like that? Is it 5 people or 50? 500? I would guess it's somewhere between 5 and 50 right now, though there are probably quite a few projects that I don't know about. They are keeping quiet. There are at least 10 or 15 that I know about, which range all the way from 20-year-olds who know how to program and have some extra time outside of their college to people who are very serious about finding angel capital to build businesses around BitCoin. Definitely runs the gamut. Lots of innovation.

43:55

Is there ever the potential for the infrastructure of BitCoin to be a paying pursuit? So, down the road when it's a thousand times bigger, could BitCoin have a Chair of the BitCoin Reserve Bank? Board of Governors? I've been thinking quite a lot about do we need a more formal BitCoin organization to kind of set standards and to try to ensure that all the products are interoperable with each other. Get more formal, maybe get some salary for those whose job it is to monitor the BitCoin network, maybe make recommendations on how to change software so that it works better or faster. I'm not sure it's necessary yet, although it might be necessary soon. My first thought is: Don't. That's probably your first thought. Second thought is maybe. Obviously, boards and committees and advisory groups can make lots of trouble. They can. I was involved in the International Standards organization standardization process for 3-D graphics technology back when I was working in Silicon Valley, and that project never really went anywhere. We spent a lot of time talking about what the standard should be and going through a whole rigorous process, making sure all our "i"s were dotted and "t"s were crossed. The end result was something that turned out that people didn't really want. That's a lesson for me, that you don't do too much up-front planning; let things evolve organically and it might turn out all right. And you'll avoid some of those problems people have when they get control of something. Well, that's the first thought--agree with you. Second thought is maybe you need something. Third thought is of course you are going to need something, because the code's going to get really big and it will take people a really long time to go through it. After a while it's not a labor of love, but just labor, and you've got to pay people, etc. As the scale grows, is that a natural process? Does the complexity of the code have to get bigger and bigger; do other things have to be added that might avoid that? It doesn't have to. There's actually a lot of pressure to keep the core system as simple as possible and allow non-core process to grow up around it that build on top of the core features. I don't think it's inevitable that the core system will get big and crusty and unwieldy, especially because we are already seeing alternative implementations of the core system. So, there won't be just one. There will be many implementations to choose from, maybe some of which will be optimized for very high volume, high traffic websites and some of which will be optimized for trying to generate bitcoins as efficiently as possible, and others might be optimized for running on your computer at home so that you have a really clean user interface.

47:51

Let's talk about fraud for a minute. If I want to buy something on the Internet now, there are a bunch of ways to do it. There's Paypal, which is a virtual wallet. There's credit card. The problem with the credit card is that somebody's got to pay a fee to use it, and the reason have to pay a fee is that some people don't pay their credit card bills; big infrastructure of cost around the process of verifying transactions, preventing fraud. Would BitCoin save some of those resources? It should theoretically. BitCoin transactions are non-refundable, so once I send bitcoins to you, there is no credit card company to call back and say: Somebody stole my BitCoin account and made this transaction; please reverse it. All transactions are final. There is still a place for companies like Paypal which give you some protection against maybe your BitCoin account getting stolen. It will be interesting to see how that infrastructure builds up. I think we are building on top of a potentially much more efficient basic infrastructure. I could imagine Paypal allowing you to store bitcoins in your Paypal wallet, like today you can store dollars and euros in your Paypal wallet and it will keep track of them separately. No reason you couldn't have a bitcoin section in your wallet. And then Paypal takes care of keeping them safe; if you have a fraudulent Paypal bitcoin transaction they'll refund your money; and they charge you a fee for doing all those kinds of service. Can you, Gavin, give me 10 bitcoins if you feel like it? Sure. You just need to send me your bitcoin receiving address. So, you say they can't be reversed--they just can't be reversed by you, the initial decision-maker. So, if you give me the 10 bitcoins and then say you were just kidding, you can't reclaim them. I would have to beg you to give them back to me. And I've give them back in a second; don't worry. The same thing would be true of merchants. So, if a merchant said I had a 14 day trial with the goods and I didn't like the product and wanted my money back, they can choose to give me bitcoins. If they don't, it's fraud--they violate the terms of their description. I can take them to court. Of course, the cost of doing that is very high for any one transaction. So, what Paypal is doing, I guess, is eating those losses so that as any one buyer I can transact fearlessly. Is that correct? Yes; they essentially spread those losses over all of their merchants and all their customers. Then they have the law department that pursues cheaters, which I don't want to have. So, what threatens the future of BitCoin? Isn't really a question of trust and usability, which I'm pretty confident at this point that it will find a niche. I am not confident that it will replace the dollar. I am pretty confident that it turns out there are several niches were BitCoin is a really useful Internet payment mechanism. I'm not sure what those niches are going to be. I think that really holds it back from replacing the dollar or Paypal or these other payment mechanisms we have is those other payment mechanisms have a huge head start; already pretty well trusted; a lot of infrastructure already built up around the existing payment systems and currencies. Remains to be seen whether BitCoin has a hard time overcoming those barriers. Could have some real advantages, though--that rate of growth. Some of the incentives built into the system are certainly helping in this bootstrapping phase. For example, BitCoin appeals to crypto-hackers; it appeals to the hard core geek crowd. A lot of the hardcore geek crowd want to see it succeed. So, we are not seeing a lot of attacks on BitCoin. There are a lot of people who might see an attack on BitCoin and will let us know. A lot of incentive for early adopters to help make the system stronger. Could the government take my bitcoins without my consent? If they can take your computer, physically take your computer that holds your bitcoin wallet, and you haven't bothered to encrypt it with a password that only you know, they can do it that way. But short of that, as far as cryptographers know, there's kind of no way for them to get your bitcoins. That's the coolest thing about this, to me--really tests your feeling about the word "virtual." It's as real a virtual currency as you can imagine.

54:41

What could make BitCoin take the next leap? Of course, being on EconTalk will be looked back on by historians as being one of the key turning points in the acceptability of the currency; but in case that isn't true, publicity is nice. Nice to get a feature in the NYTimes Sunday Magazine. That would be nice. Hoping that doesn't happen tomorrow because BitCoin isn't quite ready for it. It's still a tool for geeks and not for everybody. There's no marketing department, no government affairs, no public relations department. You are it. Or it's all of us, I guess. What might help BitCoin get to the next level? Do you see a path? I see kind of grass-roots early adoption, finding it cool, just start using it. I think you'll see it pop up on websites; you'll just get another payment button. We need to do some things to make that easier technically for merchants to do. I could imagine in not too long, a year or two, Paypal or maybe some other payment processer maybe Google Payments, one of these bit Paypal competitors deciding that bitcoins are one of the currencies you can store with them, and they will provide the service of exchanging their currencies to and from bitcoins. I think that would hugely help acceptance. Then there is a grassroots project happening in New York City right now where they are trying to get bitcoins accepted at cash registers--where you do a little rendezvous with your cellphone and you can be standing there at the cash register and pay with bitcoins. Something like that may make it really take off. That would be very cool.

Terrific show once again. I found this particular part very interesting:

"We have a pretend, a little fantasy, magic game we play, where they tell me they are sending me something. It's all electronic, all 1s and 0s that go into my bank account. I never see the cash. We think of money and payments as green pieces of paper, but increasingly they are not. There is a fiction involved that we are creating this thing called U.S. dollars. When I take the dollars from a pay source, or if you were to take my dollars, you accept them because you think you are going to be able to spend them. That's the most minimal level of trust. If no one took dollars, you'd be a fool to accept them as payment. You'd have something more reliable or something you thought you could spend."

I have always found the monetary system eminently fascinating, especially its reliance on the confidence of its users. Again, great show.

I dont understand how the government will accept there being a competing currency. A lot of their power comes from the ability to controll the dollar.
There have been local efforts before were people have tried make a currency based on gold, but the authorities shut it down immidiately.

There have been attempts to do this sort of thing locally with paper money -- with names like the Ithaca Hour -- but they don't seem to have gone anywhere. (I think the Ithaca Hour and some of the others may still be around.)

The Ithaca Hour was informally tied to the U.S. dollar, in that people were supposed to treat it as the equivalent of 8 or 12 dollars (or some other number I don't recall) for tax purposes. It was also supposed to be tied to an hour of a person's time, which would be a problem even if the dollar maintained its value.

And the rules for producing new Ithaca Hour currency were pretty informal, which didn't add to my confidence in it.

The way the bitcoin idea has been set up seems to avoid those problems. I'm hoping it works out.

Another great show Russ. I'd been waiting for you to talk about bitcoins for a while.

I'm looking forward to a future show in, say a year from now... when you look at governments waking up to a currency outside of their control that is becoming increasingly attractive to their populace.

One thing touched on struck me as presenting a couple of problems, or at least, um, "issues".

If I understood correctly, all transactions are recorded for all time (out of necessity?) in all computers that store bitcoins.

Computer storage is increasingly inexpensive, but will the number of bitcoin transactions increase so quickly that at some point there won't be enough storage for them at a reasonable cost?

The second problem is privacy: if all those transactions are recorded, won't they become available to nosy people in government or elsewhere?

I suppose a modification to the bitcoin software could resolve at least one of those problems. All transactions over a certain age could be purged out of the system, and replaced by a (much shorter) virtual transaction that summarized the purged transactions. The only exception might be the transaction that created the bitcoin in the first place.

Or might it make more sense to "recall" the existing bitcoins (bitcoin series 1.0) over a period of time, replacing them with new bitcoins (bitcoin series 2.0).

Or bitcoins could have virtual expiration dates on them of, say, 9 years after creation, which would automatically cause them to be removed from circulation and replaced by replacement bitcoins without the transaction history.

Depending on implementation details of how it was done, these might be three different ways of saying the same thing.

Yes, I would like a follow-up on bitcoins, and also other topics like Seasteading, to see what expected and unexpected challenges arose (or didn't), and how the project/organization/industry dealt with them.

Maybe you could make it a one-a-month or twice-a-quarter feature. Would it be possible for the webmaster to add some kind of nomination/suggestion/voting feature or features to Econtalk so listeners could provide feedback?

Six months or a year might be right for bitcoin, as things are starting to pick up. It might already be time for an update from Patri Friedman on Seasteading.

"If I understood correctly, all transactions are recorded for all time (out of necessity?) in all computers that store bitcoins."

Computer storage is increasingly inexpensive, but will the number of bitcoin transactions increase so quickly that at some point there won't be enough storage for them at a reasonable cost?"

No, each bitcoin (or subunit there of) records all the places its been. So its not nearly as bad as you think. It uses cryptographic proof-of-work to make sure that the bitcoin isn't lying about recent transactions, it doesn't actually store copies everywhere. This is why it takes some minutes after a transaction has been made before that bitcoin can be spent again (as some of the rest of the network has to verify the transaction.)

"The second problem is privacy: if all those transactions are recorded, won't they become available to nosy people in government or elsewhere?"

Its a P2P currency, so its fairly trivial hide your transaction by making new wallets, and then using those wallets for your transaction. Wallets are your p2p identity and can be trivially created at will and kept as anonymous as you want them to be..

The article below is from the BBC about "The Brixton Pound", a local currency that was launched in 2009, some of the issues mentioned in this article overlap with those of this very interesting podcast:

No money? Then make your own

By Marie Jackson

BBC News

Can printing your own cash actually help revive a struggling economy? That's just what traders in one London shopping district are hoping for, as they begin accepting a new local currency.

Short on cash? Then why not make your own. There's no law against it, so long as you don't try to pass it off as sterling.

And you can use whatever you please to make your money, whether cigarettes, rabbit skins or paper notes.

That's what's happening in Brixton, a south London neighbourhood where shoppers, from Thursday, will be able to hand over 10 Brixton Pounds (B£s) in return for their groceries.

Proponents of local currencies say they boost the community's economy by keeping money in the area, but critics dismiss them as fashionable gimmicks, tantamount to protectionism.

Research suggests that when the wider economy slumps, communities turn to barter systems. In other words, when there's little money around, people think about making their own.

The Great Depression of the 1930s saw a wide take-up in the US and much later, the Global Barter Club was born after the Argentine economy hit rock-bottom in 2001. At its height, the system was supporting three million people.

And today's straitened times may well renew interest in complementary currencies but, as one unconvinced Brixton shopper, asks: "What's the point?"

"A local economy is like a leaky bucket. Wealth is generated then spent in chain stores and businesses. It disappears leaving an impoverished local economy," explains Ben Brangwyn, part of the team behind the Totnes Pound, launched in south Devon in 2007.

"Local money prevents that from happening and keeps the money bouncing around the bucket, building wealth and prosperity."

Currently, 6,000 Totnes pounds are in circulation from an estimated local economy of £60m.

Gotta confess that there were parts of the idea that I could not wrap my brain around:

(1) Building in some way to inflate the coinage (at the expense of existing coin holders) using some odd game strikes me as adopting the absolute worst component of a fiat money system.

(2) The exchange rate with other currencies is a huge issue. I could not understand how you buy bitcoins using dollars: Do you buy them from a current holder of bitcoins? What happens to a bitcoin value as dollars bid for them? Answer: They go up in value. This suggests to me, therefore, that original holders of bitcoins will get stinking rich if it really took off. (Ah. The profit motive just showed up.) If the bitcoins are created through purchase with dollars, who gets the dollars? (I have a few guesses.)

(3) The notion that nefarious bitcoin creation is somehow kept in check underestimates human ingenuity as the stakes go up. (Once again, this represents the limitations of fiat money systems.) Just ask Fed watchers. The idea of benevolent overseers is, in the long run, untenable.

(4) "I'm not an economist, so maybe I should talk to one." Econonists might refer the readers to a chapter on Gresham's Law.

(5) The exchange rate with other currencies is a profound issue.

(6) Sounds a lot like Ithaca Dollars (noted above), a local currency that is, at best quaint (and still around). Should bitcoin get big, however, you may find yourself looking down the barrel of the Fed. The analogy with Bernard von Nothaus, who is doing hard time for challenging the preeminence of the dollar, seems more appropriate.

http://en.wikipedia.org/wiki/Liberty_Dollar

The counterfeiting charge against Nothaus looks like a shabby veil, and accusations of "domestic terrorism" by the prosecutor of the case illustrate that messing with the reserve currency will cause trouble. (Go to the "Federal Government Response" section in the link.)

(7) "He [the founder] does not have an incentive to degrade the system." Inflation in all its glory stems from those who get the currency first (undebased) at the expense of those holding the currency being debased. The fact that the debasement can be monitored doesn't prevent the debasement. (The Fed is a case in point.)

There are volumes written about how those who control the creation of the currency have the power. I'm still trying to figure out who this would be. In the case of gold, back breaking work stood between the holders and the debasers. What will protect the bitcoin?

Great show. Thanks for covering bitcoin. I would like to add my vote to periodically revisiting this topic to see how it progresses.

Also I would be interested in more of a high level economist and maybe legal discussion about the implications of bitcoin gaining traction, becoming a legitimate currency option and eroding the Feds monopoly powers.

I assume no constitutionality issue with individuals creating money? Since government tentacles are ever reaching why wouldn't congress just outlaw use of currency other than its own. Or offer something more effective and appealing to grab control?

Im no expert, but I can answer a couple of your questions fairly accurately I think.

(1) Building in some way to inflate the coinage (at the expense of existing coin holders) using some odd game strikes me as adopting the absolute worst component of a fiat money system.

The total final number of bitcoins is already set as is the rate of "discovery" of new bitcoins. It is programmed into the software which is already in the wild. While technically possible I guess to change those numbers around, you would have to get a mojority of the nodes on the network to be running software that contained the new programming. It seems exceedingly difficult to make any meaningfull changes to the core fundimentals at this point...meaning essentially that bitcoins are an autonomous entity and nobody is really in control any more. They can monitor and submit patches to security but otherwise its pretty hands off.

(3) The notion that nefarious bitcoin creation is somehow kept in check underestimates human ingenuity as the stakes go up. (Once again, this represents the limitations of fiat money systems.) Just ask Fed watchers. The idea of benevolent overseers is, in the long run, untenable.

Creation of new bitcoins is confirmed by the network as a whole. Your computer provides the answer to a math problem and the other computers in the network doublecheck the math and the network assignes new bitcoins to your account. If you download the software and do a transaction, one of the data points that shows up on your account is the number of confirmations of your transactions which grows over time as more and more nodes accept the validity of your money. There is no central overseer.

The second problem is privacy: if all those transactions are recorded, won't they become available to nosy people in government or elsewhere?

the money is traced by a key # which is stored on your computer. so if you want to no longer be associated with transactions you make you can simply erase the computer file and the link is broken.

of course the problem comes in with the end-points where you exchange money in and out of the system. so its probably best to create a few disposable bitcoin #s to "launder" the money once its been converted from US dollars to bitcoins. that is to say, you convert some US dollars and then send it immediately to some intermediary #s you control (strawmen) then send it to the final destination. after which you'd erase the strawmen files ... since theres no way to prove those were controlled by a specific person its effectively anonymous as cash. maybe even more so.

There was an earlier attempt at a digital currency "e-gold" which gained some decent traction. The problems with it were twofold. First of all there was a central organization to it. the second was it was primarily used as a way to conduct illicit transactions. drug dealers, money launderers, identity thieves, child pornographers were the primary users of e-gold. Due to this the government cracked down and busted the e-gold company. the interesting aspect of this is that there is no "bitcoins" organization that could be busted to stop the flow of them. The government could require that all providers block the packets...but that would be hard to implement and easy to evade.

the problem is beyond illicit transactions i dont think there is much appeal because of the cumbersome nature and technical knowledge needed to use it. it already seems to have attracted a sizable amount of illicit business i suspect that will be its wideest adoption...

i would think those offering to exchange bitcoins for dollars are running a huge risk of being implicated in money laundering cases.

"(1) Building in some way to inflate the coinage (at the expense of existing coin holders) using some odd game strikes me as adopting the absolute worst component of a fiat money system."

NO NO NO! You don't understand what is happening. The system pays people to supply computer time to process hashes which keeps the system in check (prevents counterfeiting.) The way you make new bitcoins is (very roughly) by processing and checking other bitcoins.

"If the bitcoins are created through purchase with dollars, who gets the dollars? "

They are not created by purchases, they are created by finding the appropriate cryptographic hash. Which is /hard/ and the network designs it so there will always be a finite number of bitcoins and the change in the growth rate in bitcoins will be negative. It gets harder the better computers get at the problem.

'(3) The notion that nefarious bitcoin creation is somehow kept in check underestimates human ingenuity as the stakes go up. (Once again, this represents the limitations of fiat money systems.) Just ask Fed watchers. The idea of benevolent overseers is, in the long run, untenable.'

There are no benevolent overseers. And bitcoins aren't "somehow kept in check" they are kept in check by cryptographic hashes. As people get better at processing the hashes, the problem automatically gets more complex without any human involvement. Yes one day people may figure out how to trivially break these hashes, but when that day comes... bitcoin will be the LEAST of your worries.

"(4) "I'm not an economist, so maybe I should talk to one." Econonists might refer the readers to a chapter on Gresham's Law."

You should read it as well... Gresham's law only applies where there is a forced exchange rate. There is none for bitcoins.

"(5) The exchange rate with other currencies is a profound issue."

The exchange rate isn't fixed, bitcoins is its own sovereign currency governed by the laws of math and by computer code. You exchange with people who have bitcoins who want dollars.

" I could not understand how you buy bitcoins using dollars: Do you buy them from a current holder of bitcoins? What happens to a bitcoin value as dollars bid for them? Answer: They go up in value. This suggests to me, therefore, that original holders of bitcoins will get stinking rich if it really took off."

They didn't start with a fixed number of bitcoins, the p2p network has been quietly generating bitcoins for years now.

"(6) Sounds a lot like Ithaca Dollars (noted above), a local currency that is, at best quaint (and still around)."

Not quite as its not a fixed exchange rate.

"Should bitcoin get big, however, you may find yourself looking down the barrel of the Fed. "

The distributed nature of the system makes that hard. Its possible to run Bitcoin over TOR or really any other cryptographically anonymous network. This was invented and first posted on Cypherpunks back when the Cypherpunks mailing list was still around, because of their inclinations they made it extremely resilient to such things, and made it easy to anonymize. Furthermore, bitcoin wallets are trivially generate-able so you can change your identity if things get rough.

There are volumes written about how those who control the creation of the currency have the power. I'm still trying to figure out who this would be.

That would be you, if you like. Bitcoin really is utterly decentralized-- anybody can connect their computer to the network and participate, using their computer to try to generate bitcoins.

However, "bitcoin mining" (as it is called) is getting increasingly specialized, with competitive forces making it cheaper for most of us to buy bitcoins from people who use specialized hardware to "run faster" in the race to create bitcoins.

As for early adopters getting filthy rich if bitcoin takes off: that could be you, too, if you like; everybody buying or generating bitcoins now is an early adopter. It will be interesting to see if later adopters will refuse to use bitcoins because they think it is unfair that the early adopters were able to buy or generate them inexpensively. Perhaps a "faircoin" alternative will spring up that has different rules for how coins are distributed.

And responding to Nick RE: will bitcoin find widespread use beyond illicit markets: good question. I expect to be surprised by some uses I'm not expecting.

@OleNot at all. The governent can send these guys into prison, just like they do with people who counterfeit.

who are "these guys" that could be arrested? The guys that wrote the computer code? There is nothing illegal about that, first amendment and all.

The guys who use the software? What if millions of people are using it? Can they arrest millions of people? what about the people outside the US? How do you even figure out who is using it?

The only people you could arrest are the people exchanging existing currency for bitcoins and there is probably sufficient legal precedent to do so. the e-gold creators were convicted of money laundering and running an illegal money transmission business (or something like that) i expect that anyone exchange bitcoins for dollars could be charged similarly. simply put anyone doing that within the US is an idiot but what if they are doing it in panama or china?

To me, bitcoin looks more like pyramide scheme where those who is holding coins first might get rich, snd those who enter the game later loses their money when the whole thing implodes.

The only way anyone gets rich is if demand increases. since everyone understands the rules of the game...then its possible nobody will get rich.

(2) The exchange rate with other currencies is a huge issue. I could not understand how you buy bitcoins using dollars: Do you buy them from a current holder of bitcoins? What happens to a bitcoin value as dollars bid for them? Answer: They go up in value. This suggests to me, therefore, that original holders of bitcoins will get stinking rich if it really took off. (Ah. The profit motive just showed up.) If the bitcoins are created through purchase with dollars, who gets the dollars? (I have a few guesses.)

Your first assumption was correct. The coins are sold in exchanges and it's assumed the creator holds quite a few of them being the first one able to generate them, and all. They cover that in the podcast

I heard another very good podcast on BitCoin but from the technical and security perspective. It was on Security Now episode 287. The transcript is at http://www.grc.com/sn/sn-287.htm. Their conclusion was that the technical side was done very well indicating that the creators thought through the security and stability aspects well.

Reading the comments here makes me wonder anew at the suspicion that jumps up any time it appears someone might profit handsomely from some endeavor. Profit is part of the incentive that makes the free market function yet even listeners of EconTalk are suspicious of it.

Why is the amount of bitcoins that the originator (Satoshi) has, is unknown? As any bitcoin in existence can be cryptographically verified, all of his stash must be verifiable. How does the system then avoid people from regenerating the verifiable coins that were already generated but not disclosed publically?

Also if a mathematical solution to the cryptographic problem were to be found, then couldn't someone hog all the wealth in the system? The implementation details of how the money supply is kept constant is not discussed at length.

(1) Building in some way to inflate the coinage (at the expense of existing coin holders) using some odd game strikes m

Compare it to gold. Imagine if there was only 21 million kg of gold in the ground. The first people who started mining it (also an "odd game") could find it easily. As more of the gold got mined it would became more difficult and expensive to mine, and the rate of production would decrease.
Bitcoin works in the same way: There will only be 21 million bitcoins produced, and it gets more and more difficult to produce as you get closer to that limit.

(3) The notion that nefarious bitcoin creation is somehow kept in check underestimates human ingenuity as the stakes go up. (Once again, this represents the limitations of fiat money systems.) Just ask Fed watchers. The idea of benevolent overseers is, in the long run, untenable.

Firstly: Being open source, the code is constantly scrutinised by programmers who are looking for weaknesses and will fix loopholes when identified. Secondly: If an ingenious person does manage to exploit a loophole and it is actually possible to produce "counterfeit" bitcoins, it will at least leave an electronic paper trail. That will allow people to see where the money went and how it was distributed. @Gavin Andresen could maybe elaborate.

(4) "I'm not an economist, so maybe I should talk to one." Econonists might refer the readers to a chapter on Gresham's Law.

From Wikipedia: "Gresham's law...is more accurately stated: "Bad money drives out good if their exchange rate is set by law."
The Bitcoin rate is not set by law so this Gresham's Law does not apply.

(5) The exchange rate with other currencies is a profound issue.

Bitcoin's price is free-floating, just like gold. It finds its own rate.

(6) Sounds a lot like Ithaca Dollars... Should bitcoin get big, however, you may find yourself looking down the barrel of the Fed. The analogy with Bernard von Nothaus, who is doing hard time for challenging the preeminence of the dollar, seems more appropriate.

It's not like Ithaca dollars - The number of bitcoins is capped at 21m (hardcoded into the system, and unchangeable unless the majority of users agree to change it).
I agree with you about the Fed (in the US, anyway), but bitcoin is a global currency and not controlled by an organisation. The US government could make it illegal to use but that would only drive it underground, and would not make it illegal in other countries.

(7) The fact that the debasement can be monitored doesn't prevent the debasement.

No it doesn't, but the 21m limit inherent in the bitcoin system does.

There are volumes written about how those who control the creation of the currency have the power. I'm still trying to figure out who this would be. In the case of gold, back breaking work stood between the holders and the debasers. What will protect the bitcoin?

Bitcoin is controlled only by the people who use the software. Creating it was fairly easy for the early adopters which encouraged interest and participation. But already it requires more processing power than is worth it for most people in order to create more, and it will steadily get more difficult.

Daniel, you are right, but it's much stronger than Wikipedia states it. No laws are required. For Gresham's Law ("bad money drives out good") to hold, there only has to be a fixed exchange rate. It doesn't have to be set by law, even though that is one possible way for exchange rates to be fixed between two currencies.

No one right now seems to be trying to set the exchange rate between bitcoins and the dollar, or between bitcoins and any other currency, or any commodity. It's not clear what the advantage might be to setting a fixed exchange rate (say, between bitcoins and gold, or bitcoins and oil, or bitcoins and the euro?), but I wouldn't want to rule out the possibility that someone creatively might offer that as an option. If someone does try to offer a fixed exchange price between bitcoins and any other good, commodity, or money, we'll quickly find out which drives out the other.

Historically, it was obvious to people that they would prefer shaved coins only if they were accepted at a fixed face value. The more you could shave a coin and still get goods in exchange for it at some fixed face value that someone guaranteed, of course the more you'd want to shave and again use that shaved coin, retaining the shavings for sale as metal. But as soon as shaved coins were weighed and accepted only at their flexible, floating exchange rate value, no one much cared which was used in trade. Both shaved and unshaved coins circulated without either one driving out the other when the exchange rate was flexible. The same holds true for today's modern currency. For more on Gresham's Law and why it only works when the exchange rate is fixed, see Irving Fisher, William Stanley Jevons, Laurence J. Laughlin, Willam Brough, and many others. A few famous, classic books and references explaining the topic may be found here: Search Econlib for gresham's law

I'm not an economist and everything I know about money can be traced back to Peter Bernstein's superb book called “A Primer on Money, Banking, and Gold”. What I say may be wrong, so please correct me.

1. The FED (which, by the way, is not "the government"; its position with respect to the public and private sectors is somewhat complicated) does not create money. Rather, it puts an upper limit on how much money commercial banks are allowed to create. The banks create money by lending, which causes the balance in one account to go up without a corresponding decrease in the balance in another account.

2. Most of the money in circulation is not the green pieces of paper, but electronically maintained balances. The great majority of transactions involve merely decreasing the number in one account and increasing it in another.

3. The government never authorised the banks to create money and the banks don't need any authorization. The only reason why they can do this is the social custom that people commonly use their bank accounts to transact with one another (receive and make payments).

Taking these points into consideration, it appears that bitcoin is not essentially different from better known forms of money. It resembles a gold-based currency more than "fiat money" (perhaps somewhat paradoxically) because of the way bitcoins are created through a process which is outside the control of bank officers (like mining gold).

However, should bitcoin banks appear and make loans in excess of their reserves, this will change fundamentally and the amount of bitcoin currency in circulation may then increase uncontrollably and without limit (unless these banks come under regulation). The question is, can such banks exist? I don't know enough about bitcoins, but it seems to me that, due to the technology used, the need for banks largely disappears. The banks are a middleman between investors and businesses. Doesn't the bitcoin infrastructure eliminate the need for any such middleman?

It shares with precious metals that there is a fixed limit on how much can be produced.

So go the literature or find a guest to discuss the problems with systems based on precious metals. There are many. Before anyone can advocate bitcoins they would need to demonstrate that a precious metal based economy would work.

Like a precious metals, bitcoins are hard to counterfeit. So what? Counterfeiting is not that serious of a problem. In any case, which would you trust more: a gold coin or a bitcoin?

A limit of 21M coins??? This is bizarre! The world GDP is ~$50T. So if the bitcoins spread around the world, each coin would have to be worth ~$250K. So how do you by a Coke? If, on the other hand, you wanted each bitcoin to be worth 1 cent so you could by cheap things, the total bitcoin economy would be $210K! Do you realize at 21M coins, there are fewer coins than people???

Whatever the proponents say, bitcoins are NOT and cannot be made anonymous. Governments would LOVE bitcoins. They would track everything we do. There are lots and lots of things where people want to transact business in cash. Nice old anonymous cash.

Bitcoins are inherently unfair, and borderline evil. They are "produced" by geeks using specially build computers with high powered GPUs. What value are these people producing??? Bitcoin advocates think that people who grow real food or mine real gold or produce real iPods should give them to the bitcoin "producers" who do nothing but tend computers all day.

I am shocked that you did not compare bitcoins to other virtual currencies, such as WOW Gold, Facebook credits or Linden dollars. How has the government has dealt with these? They have been around much longer and their "economies" are much larger than the bitcoin economy.

Why is the amount of bitcoins that the originator (Satoshi) has, is unknown? As any bitcoin in existence can be cryptographically verified, all of his stash must be verifiable. How does the system then avoid people from regenerating the verifiable coins that were already generated but not disclosed publically?

Well, one of the main features of bitcoin is privacy. While technically possible to figure out how many bitcoins were produced before bitcoin went public, there is no way of knowing what his account number is..at best you might determine one of his public keys but he could have many..and he could be transferring his money from account to account..or maybe he already spent it all.

There is no central repository of information. Your bitcoins reside on your hard drive until you present them to the network to transfer at which time they are verified authentic. If you have some number of bitcoins on your hard drive and its not backed up and your hard drive dies, the money is permanantly out of circulation.

Think of it like cash and your hard drive is your wallet/safe. Its not like a bank account.

There is no central repository of information. Your bitcoins reside on your hard drive until you present them to the network to transfer at which time they are verified authentic. If you have some number of bitcoins on your hard drive and its not backed up and your hard drive dies, the money is permanantly out of circulation.

If this is true, then there will be a point in time after which the supply of bitcoins will gradually and permanently decrease -- once the death rate (which is roughly stable) exceeds the birth rate (which keeps going down exponentially).

Since you have stated on a few occasions that you are not an anarcho-capitalist, I am curious if you have any CONCERNS as to BitCoin.

In other words, if BitCoin IS able to disrupt the governments ability to levy taxes, it will cease being able to function as it depends on those taxes for its continued existence, does it not?

As someone OPPOSED to anarchism, wouldn't you necessarily have concerns as to BitCoins possible disruptive effects on a stable Republic? Wouldn't this be an outcome to which you are opposed? Or do you think the government could exist via other revenue models and how?

However, should bitcoin banks appear and make loans in excess of their reserves, this will change fundamentally and the amount of bitcoin currency in circulation may then increase uncontrollably and without limit (unless these banks come under regulation).

Huh... interesting. What stops me from indefinitely issueing IOUs, thus extending uncontrollably the issuance of my own "personal" currency in excess of my actual cash balance (my reserve)? Is it government regulation? Must be, right? Government regulation is the reason evil capitalists like myself don't get away with stuff like that, right?

should bitcoin banks appear and make loans in excess of their reserves, this will change fundamentally and the amount of bitcoin currency in circulation may then increase uncontrollably and without limit.

As I understand it, unlike with the dollar, which as you point out can be spent when the physical dollar never exists, a bitcoin cannot be spent unless its electronic manifestation is transferred. Thus wouldn't it be impossible for a bank to enable someone to spend a bitcoin without actually possessing and transferring that bitcoin? That would prevent an unexpected growth in supply.

On the other hand - what are the implications of someone trying to corner the market by buying up a healthy share of the bitcoins?

What stops me from indefinitely issueing IOUs, thus extending uncontrollably the issuance of my own "personal" currency in excess of my actual cash balance (my reserve)? Is it government regulation? Must be, right? Government regulation is the reason evil capitalists like myself don't get away with stuff like that, right?

When a bank gives you a loan, your balance at the bank is increased and you can then spend the newly created money (say, using a credit card or a check). This will be accepted because others trust this bank. Nobody would trust your private checks, though.

Bank regulation is a public good, because it allows ordinary people to trust banks, knowing that someone acting on their behalf (the government) makes sure the banks do not try to con people.

@Jeffry Erickson

I think you are right! If it's impossible to spend a "fiat" bitcoin created out of nothing by a bank, then bitcoins really are like gold coins, but better -- they cannot be debased, and they overcome the main drawback of gold coins (they are inconvenient, heavy etc.). That's really clever.

If this is true, then there will be a point in time after which the supply of bitcoins will gradually and permanently decrease -- once the death rate (which is roughly stable) exceeds the birth rate (which keeps going down exponentially).

True. Well, I guess at some point all 21 million bitcoins will have been produced and then it will just be in steady decline.

Bitcoins are able to be devided down to I think 8 decimal places (although current software only supports 2 places) so that the value of bitcoins would just keep rising until .00000001 bitcoins = 1 US dollar or more.

If you have a significant value worth of bitcoins you better have a robust backup scheme...or save them online somehow.

In other words, if BitCoin IS able to disrupt the governments ability to levy taxes, it will cease being able to function as it depends on those taxes for its continued existence, does it not?

I don't see why tax evasion should be any easier with bitcoins than with any other currency. On the contrary, it might be more difficult, since the transactions are more easily traced. For example, the government would require you to declare your income in bitcoins and pay the tax authorities a certain percentage. If two private persons exchange bitcoins they probably may not inform the government of this transaction with impunity (just like they can do it now when they use dollars). However, if you run a company and sell stuff to people for bitcoins, a government agency may inspect your company and discover that you failed to declare some of your income. Why should bitcoins make any difference?

That's easy to answer -- bitcoins can be divided into bitpennies. There could be 10^8 bitpennies in a bitcoin -- small enough for a coke. When bitcoins become more valuable relative to goods, smaller fractions will be used.

Nice old anonymous cash.

Not much longer. RFID will put an end to anonymity.

Bitcoins are inherently unfair, and borderline evil. They are "produced" by geeks using specially build computers with high powered GPUs.

First of all, bitcoin production is negligible relative to bitcoin circulation. Secondly, why is it fairer for banks to charge interest on money they create out of nothing than for someone to create bitcoins by using up CPU cycles? Admittedly, it would have been even better had the computations needed to create bitcoins been useful in themselves (eg do some genome analysis? ;-)

Adam Gicz, first i wanna tell you i have not studied any economy at school or have english as my first language. So what i write might be unclear.

But i think you have got it fundamentally wrong when it comes to how money are created by the Fed and later in banks.

First the Fed buys a bond from a bank by money it have just printed.

Lets follow 10 dollar of those newly printed money. And lets say the bank is required to keep 10 % in reseve.
The bank gets the 10 dollar, and lends out 9 dollar to you, Adam Gigcz. You buy music n for 9 $ in the Istore. The Istore puts the 9 dollar in its own account in the same bank. From those 9 dollars, the bank lends me 8,10 dollar and i buy some music at the Istore too. Istore puts those 8,10 dollar in the same account, and has got 17,10 dollar combined from our buys. So the 10 dollar bill has simply mulltiplied into more bank money. And it will continue to do as the money get lent out repeatedly.

Similary, someone might start a bitcoin bank, and as it appears that the whole currency is completely unregulated, there is risk of fraud and too much leverage. You see, to have a bank business you need the ability to force the lenders to pay you back. In civil society, it means that banks can use the police and justice system if you decline to pay your rent. When the mafia lend you money, they come after you with a gun if you dont pay the money back.

So it appears that the bitcoin economy will be an economy without any banks at all. Since how are a bitcoin bank who runs it business without support of the government be able to force the borrowers to pay the money back? If you have loan in bitcoins and declines to pay them back, what leverage can the bank use? They cant use the police the government doesnt apporve of them.

My knee-jerk response: Right! Bankers are the only people who should get rich creating money!

My thoughtful response: new bitcoins as a percentage of all bitcoins outstanding is constantly decreasing. Most transactions will involve people trading old bitcoins, so most of the economic value being generated won't go to the people generating new coins-- it will go to the people trading with each other.

And RE: counterfeiting and a potential "paper trail" -- if your bitcoin private keys are stolen and your bitcoins are spent by somebody else, you can find out when they are spent. And you can find out what bitcoin address they were sent to... but you probably won't (and can't) know who owns that address to ask for your money back or to tell them that they received stolen coins.

I think the biggest problem (and worst sell on the part of the interviewer) is the aspect of growth rate in the supply of bit-coins. This idea for a 4 year half-life on currency generation rate is arbitrary and ignorant. Bit-coin might work if the system can remain truly distributed and in ,the future, currency growth rate can be decided intelligently by the cloud. However, if it operates as it was described here then it is no different from the dollar based system aside from being so small and simple that can be grasped easily (and won't be used.) A predictable growth rate may be helpful during early volatile periods but that would need to change eventually.

I don't think Bit-coin will succeed but hopefully something like it eventually will.

I would love it if Russ or somebody could let me know how correct they think I am with the following: The growth of the total population historically was very slow, nearly stable from an individual's perspective. S. Kuznets (1967) gave it at 0.8% per decade from 0-1750 AD. The growth of the economy in terms of wealth and ability to produce more wealth was nearly identical to growth in labor. The rate at which gold was slowly injected into the money supply was close enough to the economic growth (and also directly related to population) that it worked well as a currency. Around 1750 both with increase population growth and then in the 19th century with huge increases in technology based productivity gains, gold supply became too unrelated to economic growth for it to continue to work as currency. Deflation and inflexibility forced gold to be abandoned.

Central bankers since then use arcane but flexible decisions to try to match money supply to the actual economy (somewhere around 1-10%/year) by interest rate adjustments. The GDP in particular has been a reasonable indicator of actual growth. Although, it includes spurious exchange, it also fails to capture other transactions like unpaid work and so on balance has worked okay. It does have big problems though. It relies on central organizations and therefore is politically malleable and constrained by unrelated government and state properties. Furthermore the increase in money is moved through financial organizations and therefore trickles down through society (rather than going to prospectors or cryptogram solvers.)

Also, recently the system has been destructively exploited by the financial sectors. Even before 2007 huge wealth was being acquired by financial institutions by doing fundamentally worthless and even destructive activities. The question is where was that wealth coming from or being reallocated from? Then, and especially now, that wealth clearly was coming from all of us and not from looser single entities. Not just by bailouts in the US. Financial activity (including loans to individuals but especially through financial instrument trading back and forth in that sector with itself) was counted toward economic growth. This has caused our (central banks) assessment of actual economic growth to be increasingly wrong. Which lead at least to misallocation of capital and probably huge effective inflation. It was as if (actually worse than) the financial institutions and traders were shaving a bit of gold off of every coin in circulation. (And then using it to buy empty houses and consumption.)

The problem is that currency needs to correspond to real wealth and grow and move proportionally with it. From a growth perspective we especially want to move money towards activity where more future wealth will be generated. If the decisions involving monetary supply were distributed in such as way that the growth of money was more efficient and accurate and unaffected by governmental interests and constraints then something like Bit-coin would be a huge improvement.

At least it can inject new money throughout the whole system. Is there anyway to use that distributed form to more accurately gauge growth and wealth?

As I understand it, unlike with the dollar, which as you point out can be spent when the physical dollar never exists, a bitcoin cannot be spent unless its electronic manifestation is transferred. Thus wouldn't it be impossible for a bank to enable someone to spend a bitcoin without actually possessing and transferring that bitcoin?

If bitcoins are used in fractional reserve banking, there will be created bank money out of bitcoins as well.
Commercial banking requires the ability to use force if a loan isnt repaid according to agreement. So if the bitcoin currency doesnt have support from the legal system, it will be alomost impossible to demand a repayment of a loan. ( Unless the bank has its own armed forces!)
My guess is that without a banking system bitcoin will be a poor competitor to the existing fiat currencies. Because if you cant make bitcoin-loans, you are forced to use the dollar if you want to borrow some money to get an education, to buy a house or start your own business.

@Lauren, point taken but I don't see why anyone would offer a fixed exchange rate between Bitcoins and another currency and I think they would be unwise to try.
That is because other currencies are constantly debased by printing or debt creation, so you would expect the bitcoin exchange rate to change accordingly (ie increase in value against other currencies).

...it seems to me that, due to the technology used, the need for banks largely disappears. The banks are a middleman between investors and businesses. Doesn't the bitcoin infrastructure eliminate the need for any such middleman?

That's correct. This has advantages and disadvantages:
Some advantages are that there are no middleman transaction fees, and that the transfer of money is irrevocable (ie no bounced checks or chargebacks by scamming customers).
A disadvantage is that the transfer is irrevocable (eg you cannot have the payment reversed if you are cheated by someone).

Where a "bank" might be useful is to hold money for people who do not want to be responsible for keeping their "wallet" file safe on their own computers.

...lets say the bank is required to keep 10 % in reseve. The bank gets the 10 dollar, and lends out 9 dollar to you...Similary, someone might start a bitcoin bank...

Yes I think you're right about that. An unregulated bitcoin bank that lends out deposits would have no requirement for a reserve. I think that anyone depositing bitcoins with such a bank would be taking a risk similar to lending money to a startup company or to a friend who's going to break the casino at las Vegas.

This idea for a 4 year half-life on currency generation rate is arbitrary and ignorant.

What this does is it generates interest in bitcoin, encourages early-adopter (with incentives gradually tailing off as bitcoin grows) and distributes ownership of bitcoins. It is a much better way than, say, the founder generating all the money for himself and then trying to get people to accept it as payment from him. C
an you suggest a better way?

...if it operates as it was described here then it is no different from the dollar based system aside from being so small and simple that can be grasped easily (and won't be used.)

Did you miss the whole point of bitcoins being limited in number compared to dollars that are created and debased on a political whim?

"A limit of 21M coins??? This is bizarre! The world GDP is ~$50T. So if the bitcoins spread around the world, each coin would have to be worth ~$250K. So how do you by a Coke? If, on the other hand, you wanted each bitcoin to be worth 1 cent so you could by cheap things, the total bitcoin economy would be $210K! Do you realize at 21M coins, there are fewer coins than people???"

Bitcoins are theoretically dividable up to 8 digits. So while there are fewer theoretical Bitcoins than people, there are far far far far more actual units of currency than that.

So there are 21M * 10^8 actual theoretically possible units of currency. Currently however the software only divides them up into hundredths, and since they are roughly about 80 cents a single hundredth of a bitcoin is a bit less than a cent.

...it seems to me that, due to the technology used, the need for banks largely disappears. The banks are a middleman between investors and businesses. Doesn't the bitcoin infrastructure eliminate the need for any such middleman?
That's correct. This has advantages and disadvantages:
Some advantages are that there are no middleman transaction fees, and that the transfer of money is irrevocable (ie no bounced checks or chargebacks by scamming customers).
A disadvantage is that the transfer is irrevocable (eg you cannot have the payment reversed if you are cheated by someone).

Where a "bank" might be useful is to hold money for people who do not want to be responsible for keeping their "wallet" file safe on their own computers.

I think you miss the point that a banks main advantage is economy of scale as far as infestructure around screening prospective borrowers and having contract lawyers on retainer. You are free to do all this yourself if you want. Trying to find borrowers and screen them and write a loan contract and collect on something like a $5000 loan is prohibitive..thats why banks are in business. We put our money there because they pay a small percentage and have free checking. The need for a checkbook may go away I guess, but theres still a role for banks.

...lets say the bank is required to keep 10 % in reseve. The bank gets the 10 dollar, and lends out 9 dollar to you...Similary, someone might start a bitcoin bank...
Yes I think you're right about that. An unregulated bitcoin bank that lends out deposits would have no requirement for a reserve. I think that anyone depositing bitcoins with such a bank would be taking a risk similar to lending money to a startup company or to a friend who's going to break the casino at las Vegas.

As a counter point...If, because of the Feds rampant printing of money to cover all the bad loans, we go through a period of hyper-inflation and although you still have the same number sitting in your bank account, but it has 50% the buying power of before then you lost value if not money.

If an unregulated bitcoin bank makes bad investments and declares a loss and theres a run on the bank and you only get 50% of your money back...seems like the same result to me.

There still could be an insurance scheme to protect depositors, but ultimately instead of printing money to cover bad investments, someone would have to take the loss...be it an insurance company or bank stock/bond holders. Nicely, it wouldnt be taxpayers.

"Ignorant and arbitrary" is probably too harsh. At least the reasoning wasn't sold well. And I did say that it seemed plausible to have the fixed initial increase, but eventually there would have to be a flexible growth or Bitcoin will have the same problems that a gold standard has. And really, 21 million bitcoins as a limit?
That would require the use of tiny fractions of a unit if more than a few thousand people were to use it. Inflation by nominal decrease rather than increase.

"Did you miss the whole point of bitcoins being limited in number compared to dollars that are created and debased on a political whim?"

The dollar is inflated in a semi-public way by an elite group of involved and well connected participants. At the fed. Bitcoin just doesn't call it a reserve bank and the insider connections are different. Most users would not scan code anymore then they read the economic reasoning involved in treasury interest rate hikes. It is more distributed, which is good, until it needs server farms and centralization...

And really? a mysterious semi-mystical hacker with a japanese pseudonym for a founding figure? not a good feature.

@Steve
Having enough of something for it to be used as a currency, as well as being able to divide it up into reasonably small amounts is an issue if it is made of "stuff" but it's not a problem for electronic currencies. The smallest bitcoin transaction is 0.00000001 bitcoins - I suppose you could call that 10 nanobitcoins. If that amount came to be worth 1 US cent, it means (if my math is correct) that the total bitcoin economy would be worth $21 trillion. So it does scale pretty well.

You're right that most people would not scan the code. But enough people do (and will if bitcoin becomes popular) that if there is anything suspect you can be sure there will be a huge reaction and advisory for people not to use the changed version of the software.

It's quite possible that unforeseen problems will crop up in future. After all, 20 years ago computer viruses and email spam were virtually unknown. But I think that this is a really interesting concept with great potential that has been thought out very well. Although it has been viewed suspiciously by some people I have not heard a convincing technical or economic argument against it. Bear in mind that it's not the right tool for every purpose but I think it has its place. I'd be very interested to hear more economics discussion and analysis of it.

Yes, the mysterious founder issue is weird. But he gave bitcoin a kick start and there is enough interest and expertise for it to continue even without his participation.
You can read the design paper at www.bitcoin.org/bitcoin.pdf

The biggest problem I foresee is that the anonymity to bitcoin does lend itself to illegal transactions, tax evasion and money-laundering. And because of that I think it is likely that most governments will outlaw bitcoin. That won't stop it being used but it will drive it underground so that it is ONLY used for illegal activities.

I think the rest of what you say is correct, but this first step is not. The FED does not “print money” - neither literally, not metaphorically. It is the commercial banks that “print money” by increasing balances in their customers' accounts (lending). However, if they participate in the Federal Reserve system, they are obliged to maintain a certain percentage of their total balances with the FED. This puts a limit on how much money they can create by lending. The FED is a restraining factor, not the printer of money.

The monetary system is like a cart (us, the public) pulled by powerful horses (the banks). If left alone, the horses tend to pull the cart too fast (give too many loans) for the safety and comfort of the passengers, so the passengers arrange for a coachman (the FED) to hold back the horses. When the coachman relaxes the bit and the horses pick up speed, some ignorant passengers cry out, “Coachman, you're pulling the cart too hard, stop it!”

Of course, in a sense they are right: it is the coachman who will be responsible for the crash, not the horses. They are just horses. But if a passenger also cries out: “Down with the coachman, get rid of him,” she is not very wise. Like the banks, horses do have some instinct of self-preservation, but, firstly, they are not quite in the same position as those sitting in the cart, and secondly, they are prone to reckless “exuberance” (was that Allan Greenspan's word?).

I think reason why the bitcoin currency is different from traditional currencies (both gold and paper money) in that the latter are sufficiently inconvenient to handle, so that banks are able to offer an attractive alternative. You don't want your salary in cash (green bills), right? It's much more convenient if your employer can just increase the balance in your bank account. You don't want to keep an iron safe filled with green paper in your house, right?

In exchange for this convenience, we agree to use certain numbers (account balances) maintained by banks as currency, the means of exchange. Because these numbers can be changed up and down at the discretion of the banks (unless regulated to some degree by the FED and similar institutions), we give the banks the wonderful opportunity of lending us what they don't have and earning interest on it!

Now, since bitcoins provide the same convenience as the banks do, we no longer need the banks; not for the purpose of creating currency, that is (the banks have other important functions, and the bitcoin will not threaten those). If people really do start to use bitcoins, they will no longer need bank accounts just to transact (receive a salary, pay for the groceries etc.). Eventually, credit cards and checks might no longer be accepted -- everyone would insist on being paid with bitcoins.

Banks might still exist as lending institutions, but only in the following way. Suppose I have accumulated a large store of bitcoins that I don't expect to need soon. I can deposit them at a bank (if I trust it) in exchange for some interest. The bank can find a promising business (something I could not easily do) and hand the bitcoins to them, in exchange for a slightly higher interest (the bank's profit). (It would also be the bank's job to enforce the repayment of the loan.) But then the business would not be satisfied (as it would be now) with merely a higher balance on the account maintained by the bank -- it would need the actual bitcoins! Therefore, the bank would not be able to lend out more than it had taken in as deposits. In other words, it would not be able to create currency.

Because the number of bitcoins in circulation would first grow at an exponentially decreasing rate, only to level off later and eventually even start decreasing (because of inevitable lossage), the economy driven by this currency would be in a state of permanent deflation. Unlike Zimbabweans, who have to deal with an increasing number of zeros after the initial “1”, bitcoin users would have to deal with an increasing number of zeros before the final “1” and after the initial decimal point. This is not a technical problem for bitcoins - even the current limit of 8 decimal places could perhaps be lifted. It's not the number of zeros that is important, it's the dynamics.

It is true that the deflation would be very stable and predictable, but it would still have the usual consequence: it would discourage consumption now and encourage saving your bitcoins for later. You can't delay some consumption - you have to eat constantly, for example. My (economically naive) expectation would be that the production of food and other basic necessities would become more important at the expense of luxury goods.

@Ryan, @Daniel - the comments in this forum appear in a somewhat haphazard order (not chronologically) and I missed your posts when I wrote mine. I wish I had acknowledged some of your points, with which I quite agree. For instance: “The need for a checkbook may go away I guess, but theres still a role for banks.” (Ryan). Or the arbitrary divisibility of bitcoins (Daniel).

I still disagree with many posters here in that I see the FED as restricting money supply, not as the printing press. It is the commercial banks that create money. The promise of bitcoins is that it would deprive them of this power, which the FED is so ineffective in curbing (perhaps because it is partly contolled by the banks -- see the institutional structure of the FED, the Boards of Directors with their Class A directors who are bankers elected by the commercial banks etc.). The bitcoin would do this at the expense of deflation, though. Is this good? I don't know. I think it might play out in many different ways.

I am skeptical about bitCoin and feel there are legitimate questions to be raised. It seems to me, However, that many here seem to not be raising questions or potential problems, but presenting the problem and providing the answer without knowledge of the potential rebuttals.

Many statements seem to be of the form "I don't understand x, therefore x must be flawed" or "x is just impossible."

I am not sure off the top of my head, but I think the first is the logical fallacy of an argument from ignorance. Just because YOU don't understand it doesn't mean there is a problem with IT.

The second is a bare assertion. Demonstrating something is IMPOSSIBLE is very hard and places a strong burden of proof on someone making such a claim, and as yet I have not seen someone present such evidence.

@Steve:
"And really? a mysterious semi-mystical hacker with a japanese pseudonym for a founding figure? not a good feature."

He doesn't inflate the currency, he just wrote the original code. You can SEE the code and know /exactly/ what it does, so you don't need to be afraid of it. If it bothers you, you can even write your own code that conforms to the bitcoin spec, and it will also work.

@Adam Gaz
"My (economically naive) expectation would be that the production of food and other basic necessities would become more important at the expense of luxury goods."

Generally in an inflationary regime, durable goods and assets rise in price because the dollar isn't a very effective store of value. So you see things like stocks, housing, gold, etc go up in price.

I guess one of the main issues with collecting taxes from BitCoins is that, as Andresen says, it need not be (nor should in his opinion I believe) a universal currency, but one of many competing currencies. This raises the problem of which currency to tax in and what exchange rate to offer if the gov't excepts multiple currencies. Also bitCoins are not physical, and although physical money is getting rarer, there would need to be developed some kind of card system in order for it to be practical as a ubiquitous currency.

One more thing, how would governments deal with national debt? Again, unless BitCoin becomes the sole, unrivaled (no serious competitors) currency, it would greatly complicate cross country monetary matters.

Also, BitCoin is A LOT harder to track than you seem to think. That is why certain illegal operations have already latched onto BitCoin (see their website). Although you can easily track the flow of funds, velocity, etc. of BitCoins, it is easy to make the accounts anonymous so that no one knows specifically whom those funds are coming from. Again, very hard to tax.

Also, Russ, I just listened to the podcast with Art De Vany and you didn't get to talk to him about the economics of movies/show business.

I think De Vany is a very interesting guest and I would love to hear more from him about these topics, and some more about evolutionary fitness too(although I'm not running around with a dead deer on my shoulders!)

I dont think bitcoins or some other e-coin will wipe out national currencies. I think it would co-exist, but like the mp3 file, it has the potential to break many current business/tax models.

The privacy and flexibility that bitcoins offers could be a game changer. Whats to stop you from banking on the other side of the planet? Theres no fees for transfering the money back and forth. Theres no need for even a name and address..just your public/private key. If you dont need a checkbook or cash anymore, then you dont need a local bank with atm machines in your area.

I would guess the ability of a particular government to collect taxes would be drastically reduced

Taxes, I think would have to move to a consumption/use tax. A federal sales tax and/or a point of use tax like a toll bridge.

Credit cards..their primary business of giving a 30 day loan followed by exhorbitant interest rates all so you have the convenience of not having to carry cash...would that still be needed? Their side business of aggregating your spending habits and selling that off to advertisers or worse, the government certainly would go away..at least I would opt out for sure.

Ryan, have you read my posts?
Banking reaquires trust between the borrower and the lender. And without some type of enforcement, usually by use of the law, banking is impossible.

There needs to be punishment for people who dont repay their loans, and there needs to be sanctions and regulations of a bank, else they will gamble with or steal other peoples money.

I cannot believe the ignorance and lack of understanding of finance and economics from many of the supporters of bitcoins. One should expect that you at least have thought these issues through. Instead it feels like you are lacking basic knowledge. Sure you are smart guys, but the complexity of currency requires study.

I have the right to be very negative towards bitcoins, since there are many people who are investing their own money into it, and who dont understand what they are doing.

I dont claim that i understand bitcoin or its future prospects. But at least i know my limitations. And anybody who invest in that currency need to know the huge risks involved. And its clear to me that many of its supporters have no idea.

I expect people who are into bitcoins to be more knowledgeable about econmics than me. But that isnt the case most of the time.

1. Re tax collection. I still don't see why bitcoins would make any difference. The government does not collect taxes by tracking money. It uses other mechanisms, such as strict accounting rules, government-registered cash registers, property registers, heavy penalties for undeclared taxes (it works like bus tickets -- they are rarely checked, but when it is discovered you hadn't bought one, the penalty is much higher than the price of the ticket).

2. Money laundering is a different issue, but it is an issue for the police, not the tax authorities. Indeed, bitcoins would deprive the police of one instrument they currently use to hunt down criminals. It's not very effective, though, since money laundering is quite easy even now, at least for big players, thanks to the offshore banking system. It is true that criminals have to get their proceeds into the banking system, but it's sufficient if there is just one entry point. Some small fry crooks would indeed find life easier in a bitcoin world, but this drawback would be amply offset by greater freedom for law-abiding citizens. I mean, if handguns are legal, would bitcoins be made illegal because they would be a nuisance to the police?

3. What currency would the Treasury accept for the payment of taxes? Currently it accepts checks drawn on commercial banks, and makes its payments with checks drawn on Federal Reserve banks. This works, because the Treasury has an account with the FED, and commercial banks have accounts with the FED. If people accepted bitcoins from the government, the government would presumably accept bitcoins as tax payment.

4. However, the spread of bitcoins would be a huge crisis for the banking industry, and since the banking industry has huge influence on the government, I expect the government to resist fiercely. So, the current democracy deficit would have to be fixed first (see, for instance, Larry Lessig: Republic, Lost).

5. Re everyday use of bitcoins: you could keep your bitcoins in a mobile phone even with today's technology. There is a problem, though: the rather long delay before the transaction is verified. Certainly too long to pay in a shop.

6. @AHBritton: “how would governments deal with national debt?” - could you elaborate? Do you mean internal debt or foreign debt?

@Ole: I think you are confusing two things: money creation and lending. Currently the two are indeed wedded to one another, but the bitcoin would change precisely this.

The currency we are using now is balances in bank accounts, which come into existence when banks make loans. Almost all the currency in circulation, which people need to transact with one another, is loans (on which banks are charging interest!). Once there is an alternative, lending and borrowing will be decoupled from money creation. The banks will hate this, obviously, but they will still be able to function as lenders. The difference will be that they will be able to lend only the bitcoins that people have actually deposited with them. The issue of trust between the depositor, the bank and the borrower is not changed by the bitcoin. Of course, I would deposit my bitcoins with a bank only if the bank signed a legally binding contract with me, promising to repay me the bitcoins (and some interest) later. Same in the opposite direction, that is, if I'm the borrower (except that the interest will be much higher ;-)

Money is indeed based on trust, but a completely different kind of trust, one which is not based on police enforcement (apart from the prevention of counterfeit money, which the bitcoins are much more resistant to than today's money). Here is how it works: I will accept $$ as payment for my product and service, only if I am confident that $$ will be accepted by others when I need to buy something. The police and the legal system have nothing to do with it. The trust comes from the social custom of using $$ as a means of exchange.

The fact that we now accept payment in the form of an increased balance in a bank account was never sanctioned by the government and is not subject to legal regulation. We just do it, because we know that others do it, too.

"I would deposit my bitcoins with a bank only if the bank signed a legally binding contract with me, promising to repay me the bitcoins (and some interest) later."

Quote 2.

"The fact that we now accept payment in the form of an increased balance in a bank account was never sanctioned by the government and is not subject to legal regulation."

In the first quote you say you will trust a bank paying you back your money as long as its legally binding. In the next quote you say that we shouldnt trust the banks and shouldnt trust payment in the form of bank money.

If you are not able to see these contradictions, it validates the comments i made in the post above.

It appears as if you dont understand how modern banks works. A bank doesnt keep the money you think you deposit to them. They lend them out.

All what the bank is doing is claiming that it will at any time be able to pay you back your money.

Even if you create a bank account in a bitcoin bank and save your money there, the bank is NOT saving or storing your money. It only claims it is able to pay back your money.

If a Bitcoin bank is lending out some of the money you have saved in the bank, MONEY IS CREATED.

@Ole: There is no contradiction between the two statements you have quoted, but I must apologise for having picked a misleading example. People don't usually put their savings in a current account - only just enough for immediate needs. It is the banks that lend large sums, and therefore it is the banks that need legally binding contracts, the police etc.

The risk I face by having my salary paid at the end of the month into my current account is minor. Once this is done (or earlier, if I have a credit card with the bank), I will spend the money and the balance will soon, all too soon, go down to zero. If the bank ran away with the money immediately after the transfer, I'd lose maybe $3,000, but the bank would be out of business. I don't need the police and the law to give me the assurance that they will not do this. They'd rather do more business with me, and especially with my employer and the rest of their employees, next month and the one after that and so on.

Do I understand how modern banks work? I'm sure there's a lot I don't understand! But the basic mechanics of money creation seem fairly clear to me, thanks to a slim book written by Peter Bernstein nearly half a century ago (I mentioned the book in my first post under this podcast). Is the book inaccurate or out of date? Well, it had a second printing in 2008, with a brand new introduction (and a glowing endorsement) from no lesser a figure than Paul Volcker himself.

You say: “A bank doesnt keep the money you think you deposit to them. They lend them out.” Well, actually, they lend out money nobody ever deposited to them. See, that's the trick. That's how money is created. When I use my loan (created out of thin air) to pay for a new car, the check will merely be deposited with this or that bank, so the system as a whole will not have to pay out anything.

This is based on the trust and confidence shared by all that a check will be accepted as payment. Even the government accepts checks when taxes are paid. As Bernstein puts it, “The use of currency, then, is determined by custom and convenience, rather than by any law, regulation, or Government mandate.” (p. 34).

Once bitcoins replace balances in bank accounts as the means of exchange, banks will not be able to create money. You say “If a Bitcoin bank is lending out some of the money you have saved in the bank, MONEY IS CREATED.” First of all, if they lend out the money I have saved, no new money is created -- old money is merely recycled (circulated). Secondly, If bitcoins are the currency, I will need the actual bitcoins, not just a number in some bank account. If I buy a car with bitcoins, I'll pay with the actual bitcoins, not with a check drawn on a bitcoin bank. The latter simply would not be accepted as payment.

"Well, actually, they lend out money nobody ever deposited to them. See, that's the trick. That's how money is created. When I use my loan (created out of thin air) to pay for a new car,..."

Banks dont create money out of thin air. They lend the same cash several times. If you have got a 10 dollar bill, 10 bitcoins or 10 gold coins and saves them in a bank, the process is the same.

The bank will keep a fraction of those cash and lend out the rest. Thats why its called Fractional Reserve Banking. A fraction of the cash is reserves.

Cash is the base in a currency, and out of that base, money on bank accounts can be created. Because the same cash are been lent out several times, the money on the bank books are many times bigger than the amount of cash around.

Cash is the monetary base of any currency. Banks dont create check money out of thin air but from the monetary base. Banks will create check money out of bitcoins if the bitcoins are the monetary base. It doesnt matter what base money you have, gold, fiat money or bitcoins. Check money can be created out of all these base moneys.

This will be my last post regarding this matter since i dont wanna ruin these webpages with repetitive posts.
Im sorry, but my patience discussing this topic is over. If you dont understand this simple process, i cant help you. Good bye.

@Ole: I don't want to beat a dead horse either, but let me just say -- not for your sake, if you've lost patience, and certainly not to annoy you -- but for the sake of others who might read this exchange: you are just wrong. Money is created by banks out of thin air. Admittedly, the concept is rather tricky and has the flavour of a paradox, but nevertheless this is what actually happens. Let me close with a somewhat longer quote from Peter Bernstein, to whet your appetite for the whole book.

[...] if we were to visit the commercial banker and tell him that he has a wonderful deal because he can create money out of nothing — really, with the stroke of a pen — he would be profoundly shocked and would tell us that we don’t know what we are talking about. He would deny any connection with such a printing press operation and would insist that he is no more capable of creating money than a savings bank or an insurance company or any individual he can think of.

In fact, whether he is the fishy-eyed type or the more friendly model, the banker would point out that he cannot even lend or invest all the cash that he has, because he must always have enough on hand to meet the net withdrawals that his depositors are likely to make. No matter how we cross-examine him on this point he is sure to be adamant about it. He would stress that his bank loses cash when he has to pay for the securities he buys. He would point out, too, that borrowers usually draw out the proceeds of loans in short order, for no one borrows money and pays interest on it for the sheer joy of seeing a larger bank balance. They soon start writing checks and, when they do, his bank will be losing cash to the banks in which these checks are ultimately deposited.

Then has our analysis up to this point been incorrect? Can we really say that new money is created when commercial banks make loans or buy securities just because demand deposits go up as a result? Are those new deposits money or aren’t they? If the banker loses cash when he lends or invests, how then can he be creating money?

No, the analysis is not incorrect. New money is created in response to credit expansion by commercial banks. Although it is perfectly true that the bank will lose cash when it lends and invests, the bank has nevertheless created money. No matter how adamant the banker may be, he is a magician of sorts.

I highly recommend this short and very accessible book if you wish to understand what money really is and how it works.

This is a delight! BitCoin is a new and historically important development.

I must say that so far--I'm 24 minutes into the show--it is unfortunate that much of the discussion is about the open source software development model. That issue is basically irrelevant to what is important about BitCoin!

"No, the analysis is not incorrect. New money is created in response to credit expansion by commercial banks."

When a commercial bank lends out bitcoins, new money is created. End of story. Bernstein is saying the same thing I have said.

You seem to be lost in the choosing of words by Bernstein. Because he probably used som literary freedom when he said a banker "can create money out of nothing". More accurate is the quote of Bernstein above. Creation of check money is a response to credit expansion.

Dont be lost in words, but think logically.

Anyone with some economic credentials feel free to join in and adjudicate this dispute.

@Ole: OK, my last attempt. Imagine there is only one bank. Its vault is empty, it has no deposits and has made no loans. Time zero. Now, Jones comes to the bank and asks for a loan. Can the bank give him a loan when the vault is empty and there are no deposits? Yes, it can! The bank tells Jones: “OK, we will lend you $100. Now you have $100 in your account with us.” Lo and behold, money has been created -- there was $0 in the system at time 0, but now there is $100. It sits in Jones's account.

Jones now wants to use the loan to buy something from Smith. So, knowing that he has $100 in his account, he writes a check for $100, which he gives to Smith in exchange for the goods. Smith takes the check to the bank. The bank creates an account for Smith and increases its balance from $0 to $100, while at the same time reducing the balance in Jones's account to $0. A transaction has taken place between Jones and Smith: Jones bought some goods from Smith and paid him with money. Notice that when the transaction took place, the total amount of money in the system did not change: it was $100 all the time.

After a while, Smith wants to buy something from Jones. He writes a check for $100 and gives it to Jones, who takes it to the bank. The bank raises the balance in Jones's account to $100 and reduces the balance in Smith's account to $0. A second transaction has taken place.

Now, for the last act: Jones's loan matures: he must repay it. Does he have the money to do it? Sure enough, he has exactly $100 in his account. So, he tell the bank: I'm repaying the loan. The bank reduces the balance in his account from $100 to $0 -- poof! the loan is repaid, the money has been destroyed. The total money in the system is back to what it was at time zero: namely zero.

Now, take this basic scenario and add complications, such as interest, many banks and many customers, paper currency, credit cards, bonds, the FED, the State Treasury, etc. None of this changes the essence of the money creation (and destruction) process just illustrated. The details are complicated, there are various institutions involved, rules and customs etc. These are just facts you have to know, but the logic is not difficult to figure out, though subtle and quite surprising when you learn about it for the first time.

How many times have i told you you are wrong?
A bank cannot create money out of thin air.

The fact is that practically all the money it lends out needs to be cash and not check money as you use in your example. The check money will soon be transformed to cash because the borrower will spend the money, and other banks wont accept anything other than cash in payment. Check money are not traded between banks.

What loans creates are new demand deposits in other bank accounts. And thats how new money is created. If you read Bernstein one more time, you will realise that lending causes an increase in the overall demand deposits.

@Ole: My understanding in this area is pretty shallow and I have the impression that yours may not be much deeper, so perhaps indeed someone more knowledgeable could shed some light on these issues. Haven't we by any chance stepped into the old controversy over endogenous money?

Look at it another way: Say person A earns "real money" (M0 money supply), deposits it at a bank and the bank gives A an IOU in return (in the form of a positive bank balance). The bank can then lend out most of the real money to B, yet person A still regards the IOU money. So A and B together have more "money" in total (M1/M2/M3 money supply) than at the start, ie the bank has created money.

The same can happen with bitcoin if anyone would trust an unregulated bitcoin bank. However there is a difference: With regular money like dollars there is inflation so you need to put it in a bank to get some interest and prevent its value eroding as quickly. If bitcoin has no or negative inflation there is not such a need to put it in a bank.

Eg. if a country has 10% inflation you'll have an incentive to try and maintain the value of your money. A bank might give 8% interest on deposits, and charge lenders 12% interest on a loan. So you'll just about keep up with inflation. If inflation is 0%, the bank might be able to lend it out at 2% but what interest will they give on deposits? 0% if you're lucky, so why take the risk at all - Just hold onto the money yourself.

When listening to the podcast I knew you had found a topic that would generate a lot of comments. I think it was an exceptionally good topic, but I remain very pessimistic about bitcoin as a mainstream currency. I see strong signs that it can be a niche method and could be an excellent market to study.

However, my reservations comes from the source of the value created. The amount of bitcoin is arbitary and not based on value created. I don't believe that the problems solved by the group to be given bit coins correlate to exchangable value into other services or goods ( I don't mind if you measure those values in bitcoins or $), but to be sustainable, my view is that value must be exchanged for perceived equal value.

As the currency grows the conflicting interests are going to be very hard to manage from the controling interest that magnatize the bitcoins (prints the money).

Thanks for the great podcast and I hope this podcast expands Econtalk as a currency of relm in knowledge.

Okay, I've finished listening to the podcast. Thanks again for producing it.

The most important single thing about BitCoin appears to have been missed by some of the commentators. That is: nobody can influence the money supply. No person or organization—nor even a large group of people or organizations—can accelerate the production of BitCoins faster than the prescribed rate nor can they slow it.

This is a new thing under the sun!

It is even less manipulable than the supply of gold, which people can accelerate by investing in gold-mining.

There are other interesting things about BitCoin, some of which you touched on in the podcast, but this is the most interesting one to me.

BitCoin is sufficiently important that you should consider getting a different interviewee (find someone with a dissenting opinion perhaps?) or waiting six months and doing an update.

Here is a graph of the estimated aggregate computational power being spent per second on BitCoin, around the world:

http://www3.telus.net/millerlf/hashes.png

Regards,

Zooko

Thanks to the denizens of the #bitcoin-dev channel for answering my questions about the current state of the BitCoin network.

I applaud any attempts to bring down the Fed - maybe I should not be writing this in public, lest they send the NotHaus brigade to get me - so on that note I like BitCoin.

But BitCoin, as described by Andresen, is a flawed system that does not address the basic concerns about fiat currency nor does it add value over gold. Namely, like any fiat currency, it is created by men, therefore it is controlled by men. Andresen says the 'rules' of BitCoin can't be changed ... unless by popular vote. That may be OK when it's run by a gang of benevolent technonerds, but once guys like Hank Paulson get their hands on it - and they would if it became a source of power - they won't need much time to convince the masses that the rate of BitCoin printing needs to increase exponentially to avert various disasters. It didn't work out for Socrates either. To paraphrase: the problem, Mr. Andresen, is choice.

Gold seems "irrational" to intelligent people after a lifetime of indoctrination against it. But it has a number of properties that make it attractive as a currency. Unlike BitCoins, it cannot be created by man, and cannot be controlled by man. Unlike other less "barbaric" seeming candidates (units of energy comes to mind), it is fungible, easy to store and transport, and has limited other uses. Plus it's shiny. And doesn't require a phd in number theory to understand.

So I don't see any advantages offered by BitCoin over the status quo. Luckily, gold already exists, you can go buy some today. Just make sure it's not that LBMA stuff or GLD.

The BitCoin enterprise might usefully be considered in a broader historical context. After all, private currencies, issued by commercial banks, were common in the 19th century, and exist today in places like Hong Kong I believe. In much of the world, currency then evolved to a commodity-based government-issued monopoly, then to fiat money function not just as a medium of exchange and store of value, but also as a macro policy instrument. The role of technology in re-introducing competitive privately created currencies competing with government monopoly fiat (GMF) money is certainly intriguing.

An important question is, from the users perspective, what advantages do BitCoins offer over GMF money? I didn't feel the interview quite answered that question squarely, though a couple of factors were explored: for instance, the novelty appeal to geeks, and the attraction of money that follows a stable creation rule and is, perhaps, more likely to appreciate in value that most other currencies. With respect to the latter, there is an arbitrage condition with available dollar investment returns that must be examined. Disadvantages are obvious: severely limited market acceptance and a lack of investment opportunities using BitCoins.

Another point not discussed (though I suspect the answer) is whether the government might assert a monopoly right against BitCoin as it recently did in prosecuting Bernard von NotHaus who had created so-called "Liberty Dollars" (http://online.wsj.com/article/SB10001424052748704425804576220383673608952.html). It is possible that it was specific technical features of Mr. von NotHaus's approach to designing a competing currency that ran foul of existing prohibitive laws.

The most creative features of BitCoins are, in my view, it virtual nature using distributed computing, and the seigniorage lotttery it uses. One is tempted to believe that it has found a means of basing a currency (to establish trust in its stability) that does not suffer from the criticism of commodity-based currencies: namely the use of real resources to dig stuff out of the ground only to re-bury it somewhere. But that criticism applies here as well since real, scarce, computing power is required to base the currency (see the chart linked earlier by Zooko: http://www3.telus.net/millerlf/hashes.png ) -- distributed computing power that, for instance, could be used for alternative social purposes, such as to search for aliens (SETI: http://setiathome.berkeley.edu/ ) or for other projects (http://boinc.berkeley.edu/projects.php). Hence, opportunity cost here as well.

Sorry to post so late, but I just listened to last week's podcast yesterday. This was an excellent topic that deserves continued monitoring and assessment.

Fractional reserve banking will not be possible with Bitcoin. If someone attempts that, they will be attempting something very dangerous. There will be blood (unfulfilled promises).

The initial value that bitcoin brings is its transportability across borders and its ability to hide. Potential customers could be anyone from narcotics traffickers to men who are afraid of the courts seizing their assets in a divorce case.

Also, thanks to the clever protocol, the initial chicken and egg problem is attempted to be balanced out by the fact that earlier adopters can get rich due to deflation. That is the quintessential reason that bitcoin is not a ponzi scheme. In a ponzi scheme, the early adopters get all the value of the scheme. In bitcoin, the later adopters adopt it because they get much more value (many more merchants, much less risk, lower social constraints) than the early adopters.

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